The Long Good-Bye: Advance Notice of Layoffs – Are there compliance issues to consider?

Written by Jay Kirschbaum | May 30, 2024 3:28:39 PM

A recent Wall Street Journal article, “The Long Goodbye: Why Laid-Off Employees Are Still on the Job,” discussed several employers providing extended notices to affected employees of their ultimate layoffs, sometimes by as much as eight months. The article discusses some of the pros and cons of those arrangements, but the author seems to view them favorably as a general rule. Providing a longer period to permit employees to look for new jobs and have the chance to process the situation can be more compassionate than having security walk those employees out the door immediately. On the other hand, the authors noted that expecting people to keep working as if nothing happened can also seem a little awkward. The question employee benefits professionals might raise is: Okay, so what is the status of the affected employees, and what happens to their benefits?

Terminated Employees – Employers¹ generally have a standard process for terminated employees. The employees generally lose their healthcare and other benefits as of the termination (though some may retain coverage until the end of month in which their termination occurs). At that time, the most common process is to offer COBRA for healthcare benefits and terminate other benefits immediately. Healthcare plans include:

Group medical plans.
Health flexible spending accounts (FSAs).
Health reimbursement arrangements (HRAs).
Most wellness plans (assuming they are not incorporated into the group medical plan).
Access to on-site clinics.

Health savings accounts (HSAs) are not subject to COBRA (although HSAs are always fully vested and the accounts belong to the employee even after termination of employment). That is the case even though any employer-sponsored high-deductible health plan (HDHP), which permits the HSA participation, is subject to COBRA.

In addition to COBRA for any healthcare plans, there are often conversion privileges for life insurance options and likely specific administrative runout periods for filing claims under various plans. All deadlines are stated in the various plan documents.

The rules and processes are typically understandable by the affected employees and their beneficiaries in a straightforward termination. HR or an outside administration firm sends the documentation, and the rules for electing or waiving the various options follow the standard process.

But, how do those rules apply to “terminated” employees who remain on the payroll for an extended period?

Termination Runway – The issues can be more complex for employees on the “termination runway” described in the article. Assuming they remain full-time employees and continue to come to work every day, they would be treated like other full-time employees, and remain full participants in the various plans until they terminate their service. Then COBRA continuation coverage and any conversion rights would be available just as they would for any other full-time employee who terminates service.

However, some employees (as described in the article) did not actually go into work during the runway period, or at least not during all of the runway period. The employees continued to be paid as full-time employees, just as they were before the termination notice. They mostly remained fully employed but without the requirement to show up at the workplace. Often, they may not even be required to work, but can use that down time to look for new employment while remaining on the payroll as full-time employees. This raises the question: Are these employees still considered full-time employees under the employer’s plans, or do they hold another status? This distinction may not be clear from the terms of the employer’s plans. The distinction can raise coverage questions that are similar to those discussed below for employees who are on severance.

Many healthcare plans have an “actively-at-work” requirement for coverage. While that status cannot be used to discriminate based on health status, being home and looking for other employment while still being paid as a full-time employee would not be a health issue. Therefore, all plans must be scrutinized to confirm the individual’s status as a full-time employee pursuant to the plan's terms.

Plan documents are often overlooked by busy HR staff. The Employee Retirement Income Security Act of 1974 (ERISA) requires employer plans to be maintained pursuant to a “plan document² .” Compliance with ERISA is often seen as a “check-the-box” exercise for many. However, the substantive terms of the plan are contained in that document. Therefore, the employer should review the documents to ensure they provide the benefits that the employer intends. For instance, an employer may want to continue to provide benefits to those employees on the “termination runway.” If so, they would want to make sure that the definition of eligible employees includes those on the payroll who may not be “actively at work,” as an insurance carrier might define it.

Many plans offered by employers are not ERISA plans because they are maintained under an exception carved out by the ERISA regulations. That exception applies if:

• The program is funded by group (or group-type) insurance.
• No contributions are made by the employer or employee organization.
• Employee participation in the program is completely voluntary.
• The sole functions of the employer (or employee organization), with respect to the program, are, without endorsing the program, to permit the insurer to publicize the program to employees or members, to collect premiums through payroll deductions or dues checkoffs, and to remit them to the insurer.
• The employer or employee organization receives no consideration in cash or otherwise in connection with the program other than reasonable compensation, excluding any profit, for administrative services rendered in connection with payroll deductions or dues checkoffs.

Many so-called “voluntary plans are not subject to ERISA if they meet the exception (as described in the box). Nevertheless, they often come with other rights for the participants. For example, group-term life insurance supplements are often offered as non-ERISA plans and can provide conversion rights if exercised timely. Therefore, employers must also be aware of the timing issues for these types of plans.

When an employee is no longer eligible for coverage under the plans’ terms, the best practice is for the employer to terminate the coverage and offer COBRA for the group medical plan and any conversion privileges under other plans to the affected employee. Depending on the plan terms, people who remain “on the payroll” may technically lose eligibility under the plan terms and will have a limited opportunity to elect continuation coverage under COBRA or conversion under other plans. To avoid loss of coverage, employers need to be aware of the plan terms and act accordingly.

Few health insurance carriers and stop-loss carriers for self-funded plans will question the status of any person the employer lists as an employee (or dependent). However, large claims are often closely scrutinized. If there is a reason to avoid the claim, carriers often use the coverage definitions to avoid those liabilities. Therefore, employers should ensure that the individual remains a full-time employee based on the plan definitions.

Severance – Severance programs provide another twist on the termination runway situation. Employers sometimes offer some employees an extended period where they pay the employee after the employee’s termination. Unlike the termination runway example above, the employee and employer understand that the employee is no longer actively employed. (Sometimes, that might not be the case, and the employer keeps the “terminated” employee on the active payroll. In those cases, the discussion above regarding the termination runway would apply.)

Therefore, it is clear in one sense that the employee is no longer entitled to benefits, and the plans would require the employer to offer COBRA and any conversion options that might be available at the termination of employment. However, many employees negotiate extended benefits during the severance period. While that can seem like an innocuous decision and a “win-win” for the parties, it can have complications.

First, as noted above, the plan's terms might not permit an individual who is not actively at work to be on the plan. The insurers will likely continue to pay claims as they arise, just as they would with an active employee. However, large claims sometimes go through an audit process, and if it shows that someone was not an active employee, those claims can be denied. Then, the employer could, potentially, be responsible for the claim with no insurance coverage. That can happen many months after the employee has terminated employment. In the case of this extended coverage, employees may elect COBRA, thinking they have coverage for 18 months (the typical COBRA period) after termination of employment during the severance period. However, COBRA should have likely started during the severance period. If a claim is made more than 18 months after the end of the employee’s termination, the carrier could again deny the claim since there is no obligation to provide continuation coverage beyond the period mandated by COBRA.

While there is no obligation to extend the continuation coverage beyond the end of the COBRA period, the rules would permit that extension. Often, if a request is made to the carrier before the COBRA period begins, many carriers will agree to extend the coverage beyond the mandated period.

Second, providing benefits for terminated employees could potentially cause a nondiscrimination issue for self-funded medical plans. That happens when the extension of coverage during the severance period is offered to a small group of highly compensated employees. In that event, extending the coverage to that group would likely be taxable income to them. The employer often does not report that additional income to the IRS. This is not the type of issue that typically comes up in audits. However, if there is an audit and the IRS determines that additional tax is due, the additional tax, interest, and penalties that the employee does not pay would be assessed to the employer. The employer could be liable for the total amount (the so-called “100% penalty”).

There is a straightforward way to avoid these potential issues. If, as part of the severance package, the employer determines that it should provide some extended health coverage, the employer should provide an appropriate amount of additional taxable income (cash compensation) to the terminated employee (enough to pay the COBRA costs for the agreed period, with a gross-up perhaps, for the additional tax obligation). The terminated employee can elect COBRA or use the additional compensation however the employee sees fit. The employer will include additional compensation on the W-2 of the employee and will satisfy its compliance obligations to avoid the potential risks of having large medical claims denied by the carriers.

Employees on Leave or Disability – A circumstance that sometimes arises similarly to the “long goodbye” occurs if employees are on long-term disability income or were on some other sort of leave for an extended period. HR departments sometimes keep such individuals as active members of the medical plan for months (and even years) past when the individual should have been terminated and terminated from the healthcare plan. Often, they do so because they fear the consequences of an ADA claim or because the employer sympathizes with the employee. However, the employees on such extended leaves almost certainly lost eligibility for the coverage at some point (either after they failed to return from FMLA leave or later, when even the most generous view of a reasonable accommodation under the ADA will no longer be reasonable). At the point when coverage should have been terminated, the employer is now at risk for the claims if an insurance carrier determines that the plan should not have covered the individual. Employers must diligently examine the roles of their former employees and terminate coverage when appropriate to avoid those potential claims.

In these circumstances, the individual often had employer-paid, or at least employer-subsidized, coverage for a significant period. To the extent that the subsidized coverage lasted 18 months, or longer, there is a good case to be made (and courts have held) that there is no additional COBRA period once the coverage is finally terminated. The argument is that the individual already received more coverage or less expensive coverage than the individual would have been entitled to. Therefore, there is no need to extend COBRA again. Traditionally, the conservative view would have been offering COBRA anyway at terminating the coverage to ensure the COBRA obligations are met. With the significant increases in medical expenses, that may no longer be the more conservative option. Therefore, employers will need to confer with their advisors to understand the specific circumstances and the best practices.

Conclusion – The last several years have seen unprecedented disruption and change in the workplace. Given the upheaval, many employers have been searching for methods to make necessary changes less jarring for the affected employees. Providing an extended termination runway or other “soft landing” for those employees is often a considerate and helpful option, and many employers will want to take advantage of it. However, they should understand the potential risks of those accommodations and plan for them to avoid unpleasant surprises.

¹The federal COBRA requirements apply to employers with 20 or more employees on a typical business day the prior year. Therefore, many small employers are not subject to COBRA. However, many states have insurance mandates that require continuation coverage for insured plans even if the employer is below the federal COBRA threshold so this article will not make a distinction for small employers. In addition, the COBRA rules also apply to state and local governmental employers (even if they are not subject to ERISA).

²ERISA does not apply to most church plans or state and local governmental plans. However, this World Observation about the relevance of the plan document has equal validity for those plans even if ERISA would not apply.

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